General Average is commonly seen in insurance policies and other contracts in shipping industry. English law defines a general average act as any extraordinary sacrifice or expenditure voluntarily and reasonably incurred for the common safety and for the purpose of preserving the property in peril in a common maritime adventure. The York-Antwerp Rules (YAR) lay down the items allowable in a general average claim and are always referred to when apportioning general average expenses.

But how would an expense be dealt with in general average adjustment when “equity” and “natural justice”, rather than just the YAR, are taken into consideration?

Background

In the case of “The Longchamp“, a chemical tanker was seized by Somali pirates on 29 January 2009. After negotiation, a ransom, initially demanded at US$6 million, was agreed at US$1.85 million on 22 March 2009 and the vessel was released. The owners incurred expenses of US$181,604.25 in total during the negotiation of the ransom. These expenses, including crew wages, maintenance and fuel consumed, were claimed as General Average under Rule F of the York-Antwerp Rules 1974 (YAR 1974).

The expenditure incurred by owners during detention period was allowed in the general average adjustment on the basis that, by successfully reducing the amount of ransom from US$6 million to US$1.85 million, a saving of US$4.15 million was made for the common interest of all parties. Without owners incurring the expenses, the ransom of US$6 million would have been recoverable as general average under Rule A of the YAR 1974. The expenses in relation to crew wages and fuel consumed incurred during the negotiation with Somali pirates were therefore substituted expenses under Rule F of the YAR 1974, up to the amount of general average expense saved (US$4.15 million in this case).

The cargo interests did not agree with the general average adjustment in respect of allowing the expenditure under Rule F. Rule F only applies if any extra expense incurred in place of another expense which would have been allowable as general average shall be deemed to be general average. The cargo interests argued that the initial ransom demand of US$6 million, which was considered as allowable in the adjustment if incurred reasonably, would not have been reasonably incurred and would not be qualified as general average. The expenditure incurred during the detention period was not substituted expense as it has not been incurred “in place of” the expense of the ransom payment nor an extra expense required by Rule F because crew wages and costs of fuel consumed would have been incurred by owners anyway.

High Court

The cargo interests sought a court decision on whether the disputed expenditure should be allowed as general average under Rule F. The High Court upheld the general average adjustment on the grounds that whether a ransom payment was “reasonably incurred”, “the value of the property involved in the maritime adventure is undoubtedly a relevant factor in the assessment”. If the amount of the ransom demanded was “…clearly less than the reasonably understood value of the property involved in the maritime adventure and where a saving would be made if the amount of the demand was paid”, the payment of the ransom would have been incurred reasonably under Rule A. The Court further explained that “the rule of contribution…in the adjustment…has its foundation in the plainest ‘equity’ and ‘natural justice’…” because the expenditure was incurred by the owners for the benefit of all parties concerned by reducing the amount of ransom.

Court of Appeal

An appeal was filed and the Court of Appeal reversed the High Court judgement. Reference has been made to the reports issued by the Advisory Committee of the Association of Average Adjusters and the case of Masefield AG v Amlin Corporate Member Ltd [2010 EWHC 280 (Comm)] for the typical modus operandi of Somali pirates.

The Court of Appeal summarized the meaning of Rule F which requires the sum spent to be “expenses” only; such expenses should be incurred as “extra”; an alternative course of action must have been available and if adopted, the expenditure could be allowed as general average; and the “extra” expenses must have been incurred in place of the alternative course of action.

The only two available options in reality upon vessel and cargo being hijacked, as suggested by the cargo interests, were to abandon the vessel and cargo or to negotiate, agree and pay a ransom for release of the vessel and cargo. Based on the evidence submitted to the Court, it appeared that the owners of the vessel never considered abandoning the vessel. The owners’ sole intention was to negotiate for release of the vessel. The Court considered that, whether owners paid the initial ransom amount or a reduced amount after negotiation irrespective of the negotiation period, they “…fundamentally involve doing the same thing” by paying ransom for the release of the vessel and there is “…not a true alternative course of action”. The only difference is the “extent” of expenses incurred depending on the time taken for negotiation. It was therefore concluded that there was no alternative course of action recognized by the owners. An example of an alternative course of action given by the Court was to regain control of the vessel by the use of force.

The Court also decided that, upon proper interpretation and application of the Rules, the “expenses claimed are ordinary operating costs incurred by reason of delay” and are not recoverable in general average “…for ordinary expenditure (Rule A) or for loss or damage sustained through delay (Rule C)”.

The Court went on to advise that, even if owners paid the initial ransom immediately without any negotiation with the pirates, it cannot be said to be unreasonable because this is, “as stated in the Masefield case, the safest, most timely and effective means to secure the release” of the vessel and crew. Even though “the general practice was to try to negotiate the ransom down, but that does not mean that it would be unreasonable to pay the ransom straight away” by owners. It was also held by the Court that bunkers are reasonable to be allowed as an expense “if Rule F had been applicable”.

This decision reverts the position under English law back to 2012 before the High Court judgement for “The Longchamp” that such costs were not allowed under Rule F. This would also apply to salvage negotiation where the same course of action will arrive and any detention expenses during salvage negotiation should not be recoverable under Rule F.

Ransom Recovery in Somali Pirates Cases

Given the above judgement ruling owners’ payment of initial ransom demand is not unreasonable, an interesting question arises. Instead of negotiating for a lower amount of ransom incurring additional expenses which are not recoverable under Rule F as substituted expenses, does this suggest that owners should immediately pay the initial ransom which would have been allowable as general average under Rule A, provided that the requirement of Rule A is satisfied and the applicable jurisdiction, such as English law, does not treat payment of ransom as illegal? The ransom would then be apportioned between all parties concerned and owners do not need to bear all additional expenses incurred during the negotiation of the ransom, as per the Court of Appeal decision above. From cargo interests’ perspective, although they were held not responsible under Rule F for the expenses during the detention, the court decision implied that an immediate payment of ransom by owners is reasonable and such payment may then fulfil Rule A requirements: extraordinary expenditure intentionally and reasonably incurred for the common safety in a common maritime adventure. It should be noted that the requirement of “reasonably incurred” refers not only to the amount of ransom but also the act of paying ransom. Once the ransom is considered by adjuster as allowable in general average, cargo interests have to share the ransom under Rule A and the amount of ransom would potentially be much higher than those expenses incurred during detention!

Despite the possible general average recovery for the ransom according to the Court of Appeal decision, it is important to note that such recovery depends on the circumstances of each case and may only be applicable to Somali piracy cases. The situation in Somalia is unique because local government intervention to detention or pirates activities is unlikely and thus it was not unusual for pirates to hold vessels for 9 to 12 months. This leads to the possibility of incurring substantially higher Rule F expenditures during vessel’s detention and owner’s payment of ransom without negotiating after a prolonged period might be justified in order to minimize and cancel out the detention expenses.

As the circumstances of every case are different, we strongly recommend that insurers, lawyers, adjusters and all stakeholders are consulted before the payment and amount of ransom is decided in order to ensure all parties’ interests are best protected.

Finally, we would like to take this chance to thank Richards Hogg Lindley (RHL) for their professional advices provided to Latitude Brokers! You can also refer to RHL’s summary on the “The Longchamp”, which can be found here: http://www.ctplc.com/media/413351/The-Longchamp-Mitsui-Co-and-others.pdf

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